Buy essay on The concepts of depreciation and amortization

Dear Lucy!
You asked me to explain you the concepts of depreciation and amortization. You should remember two main things about both of these terms: first, they determine two types of accounting transactions that record the loss in value of long-term assets, and second, depreciation is usually used for physical property (tangible assets) like cars, buildings, equipment, and so on, meantime amortization is used for intangible assets, like patents, copyrights, goodwill and so on.
You know, Lucy, that positive income statement is very important for investors. Many believe that just the wish to keep income statement s always positive was the main reason of Enron’s collapse. That is why amortization and depreciation are very important items of cost. Just imagine: you are the owner of the small chain of original clothes shops. You bought new printing machine to make unique prints on T-shirts and other clothes for $5000. Your accountant has to include the cost of the machine in income statement, however without the amortization transaction the annual profit of your company will be $5000 less, and obviously your investors would not like this. To avoid this, your accountant will divide the price of printing machine on five years of its useful life and get $1000 a year. During the next five years your fiscal report will contain the $1000 of amortization expense.
Sure you understand, Lucy, that my example was very primitive and the depreciation and amortization is more complicated problem. For example, though the cost of amortization can be accounted in five years, the check for printing machine will be signed in the moment of purchase and you will pay the whole sum (let us skip the issue of loans). Besides, tangible assets lose its value over time: after three years of work the value of your printing machine will be less than $5000. Sure, accountants have developed a lot of methods to record actual amortization and depreciation costs, like sum-of-the-years digits, however there are still a lot of measurement problem. One of these problems is taxation. You know, amortization and depreciation are operating expenses, or the expenses that go toward supporting a company’s operations for a given period. They are deducted from gross profit before the taxation. Tax laws is complex, too, besides, they vary from country to country and from state to state. That is why in many cases company prefer depreciation their assets to the Internal revenue service as fast as it possible, to use the timing difference as positive factor.
Sure, some unfair businesses could overvalue depreciation expense to make income tax lower, and such problems in accounting were the reason of audit companies’ appearance. External readers can read the income statement of the company and analyze the gross profit, the net profit, EBIDTA and depreciation. It is very important to explain the situation to your investors, because they can ignore the economic reality of depreciation expense, overvalue the earning profit of your business and find their returns to be too small.
Perhaps you are agreeing that this system of accounting is far from ideal. However don’t forget that this system including amortization and depreciation developed in many years under the pressure of external factors like taxation law. So we rather study it instead of developing something new, because every new idea will just make accounting rules more complicated.
References
“Internal Revenue Code:Sec. 197. Amortization of goodwill and certain other intangibles” From TaxAlmanac, A Free Online Resource for Tax Professionals.